Student accommodation: risks and opportunities for investors
11 October 2016
Student accommodation has become a popular choice for investors. Stewart Womersley reviews the risks and opportunities in the market
Purpose-built student accommodation (PBSA) has undeniably come of age as an asset class, and many would question whether the ‘alternative’ label is still appropriate.
Having proved its resilience after the global financial crash, the UK sector celebrated its 25th birthday in style with a record £5.5bn of investment, surpassing the North American market. This represented a tenfold increase on 2010 and more than tripled 2014’s figure of £1.7bn, so it is little wonder that in a British Property Federation survey, student housing was the specialist sector most expected to offer the best returns in 2016.
Driven originally by domestic and European institutional funding and a few small developers converting office buildings, the UK PBSA sector now has a wide variety of investors, developers and operators entering the market. Capital is coming from across the globe, with private equity, pension and sovereign wealth funds all picking up on the promising and steady returns on offer.
Real estate investment trusts (REITs) are a recent addition to the sector, with Gravis Capital Partners and Empiric launching in the last 3 years. The suitability of the REIT structure remains largely underused by UK players for student housing; however, if Property Week is to be believed, Unite Students will be converting into a REIT next year.
So why has student housing been so appealing to investors compared with other assets? There are 3 key reasons. First, it offers long-term, stable income. Rents have consistently increased above the rate of retail price inflation, with typical short-term annual leases giving operators an easy opportunity to adjust rents in line with inflation. With most students having parents to act as guarantors, there is little risk of tenants defaulting. Occupancy rates are also generally high; many operators enter into nomination agreements with universities that guarantee a proportion of beds will be taken each year.
Second, demand remains strong. The number of students being admitted to university has increased by one third over the last 10 years (see Table 1), with the much-publicised tripling of tuition fees only temporarily stalling the continuing upward trend. Demand for higher education is also acyclical, with recessions prompting people either to reskill or to delay entering the job market, meaning that PBSA can typically offer reliable returns during periods of economic turbulence.
Furthermore, with relatively little increase in university-provided beds, the number of students housed in PBSA doubled between 2007 and 2014. According to the Higher Education Statistics Agency, 83% of the 210,000 additional students went into the private rented sector, adding strain to the lack of housing in many university towns and providing a clear case for future development.
Third, PBSA is attractive from an investment perspective. It allows institutional investors to diversify their portfolios away from traditional, cyclical assets with less promising returns. The pronounced yield compression in the market – with yields on London PBSA hardening from 6.3% in 2012 to 4.5% in 2015 – reflects both robust land value appreciation and strong competition between investors to enter the market and access the long-term income on offer.
Table 1: Undergraduate admissions to UK universities by year
Room to grow?
Even accounting for this competition, the sector still offers plenty of capacity for further investment. With a third of first-generation PBSA stock and 100,000 university-owned bedrooms in need of repair – representing potential investment of £5bn – refurbishment is one area for investment opportunity. Given increased competition between institutions, universities may also seek to join forces with developers to build new housing on campus space. Sean O’Shea, CEO of developers University Partnerships Programme, estimates that most universities only optimise a quarter of their estates, with development having the potential to save institutions more than one third of their running costs.
The general opinion is that the PBSA market has not yet reached its ceiling. Nonetheless, several factors may inhibit continued growth for the sector as rapid as that of the last 5 years.
The growth in international student numbers over the last decade has been pivotal to the expansion of the PBSA sector, particularly in prime schemes, as international students – who face uncapped fees in the UK – tend to be among the wealthiest. While the tougher immigration rules on student visas imposed from 2012 had a sharp effect on the number of Indian students in the UK, to date this has been outweighed by strong increases in numbers from countries such as China and Singapore.
This does, however, mean that growing competition from developing nations focusing on establishing their own higher education sectors is a long-term threat, with China in particular investing heavily in tertiary education. Although the most successful UK universities will likely always have strong appeal for international students, if in future such students find universities in their own regions more attractive this may have a knock-on effect on prime PBSA schemes serving less prestigious UK universities.
By the same token, there have been signs that the tripling of tuition fees has seen the domestic demand for less well-reputed institutions fall, as students look for more value for money. With the reduced birth rate of the late 1990s and early 2000s due to lead to a slowdown in admissions in the next decade, there is the potential that schemes that serve lower-tier universities may be less well occupied if the basics of good location and sensible pricing are not in place.
Another key threat to the growth of the PBSA sector is opposition from local authorities, particularly in regional university towns. Planning tools used to limit the growth of student populations have included article 4 directions, which restrict the proportion of student houses in a given area, and the discretionary use of the Community Infrastructure Levy, which is not set nationally and can be used to disrupt viability. However, the pressure that forecast future increases in student numbers will place on the housing market does give potential for developers to work with universities to persuade councils of the benefits of PBSA.
The recent changes in stamp duty may also be a potential threat to investment, with the Chancellor deciding not to exempt commercial investors with more than 15 properties from the newly applied 3% point surcharge on purchases of second homes.
It is worth recalling that despite these risks, PBSA remains a strong prospective market in the UK – in large part down to pent-up demand for student housing, if nothing else. Provided operators follow the lead of the likes of Unite Students and Urbanest in prioritising the fundamentals that pay off over the long term – such as good location, superb service, great amenities and sensible pricing – they are unlikely to fail.
The long-term approach is crucial, as failure to pay attention to the features that ensure high occupancy rates year in, year out will be likely to expose developers to any threats to the UK market. So long as investors keep those lessons in mind, there is little doubt that the sector can graduate with honours.
Stewart Womersley is a partner in Fund and Indirect Real Estate team at law firm Addleshaw Goddard